For six long years, Japan has suffered from legislative gridlock with opposing political parties controlling different houses of parliament (the so-called "twisted Diet") and instability at the top due to the rapid turnover of prime ministers who have hardly finished one-year administrations. These dysfunctional policy-making dynamics have prevented the government from executing long-term economic reforms even as Japan confronted major challenges, such as the trade shock brought about by the 2008 global financial crisis and the triple disaster of March 2011. As the Liberal Democratic Party (LDP) cinched a comfortable majority in the July Upper House election together with its coalition party, the New Komeito Party, these fundamental constraints on effective governance seem to have been lifted: the chapter of divided government has come to a close, and with no national election scheduled for the next three years, Prime Minister Shinzo Abe will have much needed time to implement reforms to promote economic competitiveness. The stakes could not be higher as this "third arrow" is the make or break component of the Abenomics project.

But we should not be too hasty in concluding that the political Gordian knot has been cut, paving the way for a new era of economic reform. The public has little appetite for an agenda of structural reform, electoral considerations seem to have watered down the reach of some of the reform measures of the growth strategy released in June, and the reformist mettle of the Abe government will be tested in the months ahead as the big-ticket regulatory reform items (electricity, agriculture, and medical treatment) will mobilize powerful interest groups. Prime Minister Abe must, therefore, use his political capital wisely as he confronts foes of the reform agenda--many of whom have deep links to his own party. To this end, a more focused growth strategy that identifies core priorities and specific roadmaps, as well as the skillful leveraging of the ambitious trade agreements Japan is negotiating (the Trans-Pacific Partnership (TPP) and a free trade agreement (FTA) with Europe), are the key to creating a tailwind for parallel domestic reform efforts.

A mandate for reform?

While the long-term effects of Abenomics in reviving the Japanese economy may be in question, in the short term it has already had a major political payoff: the handsome electoral win in the Upper House. The election was essentially a referendum on Abenomics as voters validated his administration's campaign to fight deflation and promote growth, and no other political party offered a compelling alternative vision to remedy the woes of the Japanese economy. But Prime Minister Abe did not receive a free rein through this election. The mediocre turnout (at 53%, it is the third lowest in the postwar era) does cast a cloud, as many people apparently were not motivated strongly enough to cast their ballot. Moreover, what Japanese voters awarded Mr. Abe is a conditional mandate, in other words, it comes with a performance requirement. The expectations are high that the government will deliver economic results that improve the life of the average person by increasing the chances of employment or wage increases. If growth is not sustained, or if its benefits are not shared widely, the popular support levels for Prime Minister Abe--which have been remarkably sturdy at roughly 60% in the first six months of his tenure--will certainly go down.

More crucially perhaps, the popular mandate is for growth, not structural reform. Clearly the two are connected as deregulatory measures are sorely needed to unleash the productive forces of the Japanese economy. But there is in fact a perception gap within and outside Japan on what is the fundamental meaning of the third arrow: in Japan, the usual descriptor is growth strategy, while outside of the country, it is structural reform. The preference in Japan for stimulus as opposed to restructuring comes across a wide range of areas. For example, while government spending to open child care centers is welcomed (Note1), deregulation to integrate nurseries and kindergartens and/or encourage private participation has been resisted, either to protect bureaucratic turf or with the charge that it will lead to a lower standard of care. Similarly, while subsidies for farming or to encourage new hires in manufacturing are popular, there is no support to change the legal regime to make dismissals or land transactions easier. The LDP is in fact responsive to these concerns, lest we forget that the last time the party had a reformist prime minister in the figure of Junichiro Koizumi, its electoral base took a hit when the party was accused of practicing "market fundamentalism."

"Forces of resistance" neutralized?

What does this election tell us about the staying power of traditional opponents of economic reforms? In fact, the election had mixed messages. On the one hand, the absence of an electoral revolt in the countryside against the LDP in the face of Prime Minister Abe's bold move to join the TPP sets an important precedent. Back in March, when Prime Minister Abe announced Japan's bid to enter the TPP, all eyes immediately turned to the 31 rural single member districts (SMD) that have acted as swing constituencies in past elections. In this electoral contest, LDP candidates came ahead in 29 of these districts, experiencing defeat only in Iwate and Okinawa. This feat is all the more significant given that past efforts of agricultural market liberalization have consistently produced electoral setbacks: the LDP lost its majority in the Upper House for the first time in the 1989 election in part due to backlash for the market opening concessions on beef and citrus (and the uproar over the enactment of the consumption tax), and the decision by Prime Minister Abe in his first stint in office to launch FTA talks with Australia contributed to the 2007 electoral defeat in the Upper House, when public distrust also ran deep over lost pension records.

The message that it is possible to join a trade agreement of unprecedented ambition and escape electoral onslaught is a powerful one, especially as it underscored a key vulnerability in the Japan Agricultural Cooperatives' (JA) lobbying clout: JA had no other party to which to defect, since none of the anti-TPP parties had a national projection to mount an effective challenge to the LDP. Reminiscent of a "Nixon goes to China" moment, it was the LDP who could traverse the road to the TPP. But the forces of resistance have not been extinguished, rather they have adjusted, and the battle over economic reform rages within the LDP. A look at the background of LDP proportional representation (PR) winners yields a veritable "who's who" list of Japanese interest groups (Note2) (postal masters, agricultural cooperatives, doctors and dentists). And even though the candidate with strong links to JA had 25% fewer votes in this election than in 2007, he still secured the number two slot (Note3). Moreover, the rank and file of the LDP is very ambivalent toward the TPP: in a survey of LDP candidates this election, half of them were non-committal in supporting or rejecting the TPP (Note4), even though the party leadership has already secured Japan's entry. This is in sharp contrast to their overwhelming support for Abenomics as a strategy to improve employment and wages (Note5).

The Abe government's strategy to avoid losing the farmers' vote in this election is a sober reminder of the many challenges that loom ahead: the ruling party has developed a sanctuary approach in the TPP negotiations, setting aside five agricultural commodities--rice, sugar, dairy, beef/pork, and wheat--as off-limits for tariff elimination. Thanks to the second arrow, this year has seen a marked increase in public works (worth four trillion yen in the second quarter), and the government has made promises to double farming income in the next 10 years. Moreover, in its release of the growth strategy, the most far-reaching structural reforms for agriculture were conspicuously absent. Summing up, the winning formula for this election consisted of promises to shelter core sectors, increase the flow of subsidies, and postpone fundamental changes.

The June growth strategy: A pre-electoral draft

For all of the awe inspired by the Bank of Japan (BOJ) Governor Haruhiko Kuroda's announcement that the BOJ would double the monetary base and pursue a 2% inflation target (popularly referred to as Kuroda's bazooka), the much awaited growth strategy released a month prior to the election lacked fireworks. The comparison between the first and third arrows is in some ways unfair, as in monetary policy it is possible in one single move to send a powerful signal to market participants that a fundamental policy departure has taken place. Wide-ranging reforms to enhance economic competitiveness are a different exercise altogether. The complexity of the task can be appreciated by the score of policy issues to be tackled in each of the three pillars of the growth strategy. Measures to revitalize Japanese industry include promotion of capital investments and venture capital, the restructuring of industries characterized by excessive competition through greater ease for mergers and acquisitions, and regulatory reform, through increased competition in the electricity sector, for instance. With the aim of nurturing human capital, the government is proposing to increase female participation in the labor force, to reverse the flow of subsidies from keeping redundant workers to instead reward new hires, and to increase the internationalization of Japanese students and universities. Finally, to develop strategic markets, the government aims to establish an institution akin to the National Institutes of Health (NIH), to boost foreign direct investment by establishing special economic districts, to increase the reach of the FTA network to comprise 70% of total Japanese exports, and to turn Japan's weaknesses (an aging population, and lack of natural resources) into strengths by becoming a world leader in healthcare for the elderly and renewable energy.

The reconciliation of competing interests, the wide array of policy tools to be deployed, and the much longer implementation timeline required for many of these reforms make the third arrow a much more unwieldy task to master. Nevertheless, the lackluster launch of the third arrow does reflect some important concerns. As some observers have pointed out, the strategy is long in ambitious goals (achieving an average of 2% real GDP growth rate for the next 10 years, doubling the stock of foreign direct investment (FDI) by 2020, and doubling agricultural exports within the next decade, to name a few), while short on specific roadmaps to achieve these targets (Katz 2013). In the area of agriculture, the necessary reforms to increase efficiency and enable market opening, for example, ending the production restriction programs (set-aside) that keep producer prices high and easing regulations on land transactions which stand in the way of the emergence of large-scale commercialized agriculture by allowing corporations to own farmland, were sidestepped (Yamashita 2013; George Mulgan 2013). And there were no deliverables on several critical issues such as labor market flexibility, corporate governance reform to enhance the role of outside directors, and the approval of medical mixed treatment to promote the wider use of treatments and drugs not covered by national insurance.

But it is too soon to flunk the growth strategy. What we have seen so far is the first installment, a pre-electoral draft of sorts, where political considerations loomed large, as no politician wants to head to the polls with potential charges that the party's economic platform will produce mass layoffs or the erosion of the national health care system--as misguided as those criticisms may be. This was a necessary compromise since the chances of passing economic reform bills without securing a majority in the Upper House would have been much slimmer (a case in point is the failure to vote on the electric reform bill before the Upper House session ended). That being the case, the heavy lifting in advancing a more focused and effective reform strategy starts now.

The post-election reform agenda: Focal points and levers

The growth strategy has been criticized for being diffuse, even mind-boggling, with scores of policy issues to be tackled. In order to correct this, the government could select a few signature initiatives that would provide a focal point for the reform effort and at the same time have wide economic ramifications. Three come to mind: electric power reform, agricultural modernization, and labor market flexibility. The proposed breakup of the nine regional electric power monopolies with the unbundling of power generation and transmission and the creation of a nationwide grid system will address some of the severe vulnerabilities exposed during the March 2011 triple disaster due to the lack of regional interconnectivity, and will boost business competitiveness by lowering the cost of electricity. Modernization measures for agriculture are urgently needed as the aging population of part-time farmers will be increasingly unable to meet the food supply needs of the country. These reforms will also enable Japan to deploy a proactive trade diplomacy on par with its international economic stature. Opponents of labor market reform predict the collapse of the system of strong employment protection, without acknowledging that a third of all Japanese workers already face no job security, and experience a significant wage gap, fewer training opportunities, and limited access to employment insurance (Organisation for Economic Co-operation and Development, 2013). Japanese companies have responded to the high legal hurdles against dismissals by increasing the ranks of non-regular workers. Therefore, flexible labor practices (allowing lateral job moves, mid-career hires, and adaptable working hours) will address the root of labor market dualism, and pave the way for larger female participation in the workforce.

The Abe administration faces a number of critical challenges in the months ahead. The increase in the consumption tax may deflate consumer sentiment, slow down growth, and diminish the chances of employment and wage gains, with a consequent drop of the prime minister's popular support. But failure to address the fiscal situation could generate an increase in interest rates and compromise the government's ability to service the debt. If Prime Minister Abe takes on the vested interests that are so well represented in his party, internal cohesion may suffer (a phenomenon that plagued the administrations of many of his predecessors), but failure to do so will frustrate genuine reform. To tilt the balance, the government must use the ambitious FTAs it is negotiating (TPP and one with the European Union (EU)) as catalysts for domestic transformation. To the extent that Japan lowers its tariffs on agricultural commodities, it will be imperative to reduce prices and increase productivity. It will not be possible to postpone long overdue reforms to eliminate production adjustment programs and promote full-time commercial farming. And there is a significant overlap between the non-tariff negotiations Japan is scheduled to hold with the United States and the EU and its own economic reform agenda in areas such as regulatory transparency, mergers and acquisitions, adoption of international standards, changes in corporate governance, and faster authorization of drugs and medical devices. Reliance on a traditional lever (international commitments), therefore, should empower Japanese reformers to achieve their new economic reform agenda.

Research Institute of Economy, Trade and Industry, IAA (JCN 6010005005426)JCN: Japan Corporate Number

Opinions expressed or implied on this website are solely those of the author, and do not necessarily represent the views of the Research Institute of Economy, Trade and Industry (RIETI).Titles, numbers, specific names, etc. on this website are as of the date of publication. In the case of reposting material from our website, contact us beforehand.